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Changing The Financial Landscape In Russia Is Not An Easy Task

Earlier this year, with the Moscow Exchange’s IPO, Russia opened its financial market to the rest of the world as part of Russia president Vladimir Putin’s plan to modernize the country and attract international investors. In the US, venture capitalists and hedge funds managers are generally still cautious. But for pioneers looking for cutting edge and potentially lucrative investments, Russia may seem worth the risk. However, Russia's entrance into capital markets presents a number of challenges.

Moscow skyline

“We’d like to show that Russia is changing,” said Andrey Shemetov, Deputy CEO of the Moscow Exchange, while visiting New York for an investment conference. “So people would understand that bears don’t walk the streets and no one runs around in winter fur hats in the summer. There are financial changes in the country.”

Until recently Russia’s security market remained isolated from international markets and in order to access capital, Russian companies had to go to London or New York. The Moscow Exchange, Russia’s highly diversified trading platform offering stocks, bonds, derivatives, Forex and money-making instruments, had its IPO in February. The European Bank of Reconstruction and Development was one of the initial investors; China Investment Corporation and a number of global emerging funds took advantage of the IPO and are now among its shareholders. The largest stake is owned by The Central Bank of Russia and, combined with other state-owned entities, the government’s stake totals 46%.

In recent months management, with the help of Russia’s government, has pushed through fundamental reforms in order to provide access for international investors and, ultimately (they hope) to make Moscow a hub for capital market activity. Reforms include establishing of a central securities depository, opening up the bond market to Euroclear and Clearstream, and, most recently, upgrading the settlement of Russian securities to T+2 to eliminate prepayment for traders. The first Russia-listed exchange-traded fund is supposed to go live this month.

Laura Brank, managing partner at Dechert LLC’s Moscow office, said in an emailed comment that her clients (Dechert is an international law firm with origins in Philadelphia, Pennsylvania, with expertise in private equities, securities and capital markets) have given positive feedback on the new Central Securities Depository and says there is interest in listing in Russia. Despite changes in legislation, however, there is still a lot of ambiguity on how in practice ETFs would work in Russia. “There is still a lot to do to create a truly transparent, predictable functioning market,” Brank said.

Since the Moscow Exchange had its IPO, Russian markets fell noticeably on crude oil, and last week the MICEX index dropped to the lowest level since November 2012. But Russians don’t get discouraged.

“We would like to find smart investors that know the market,” Shemetov said. “Of course the Russian market is an emerging market… The expectations should be right.” Feedback and strategic advice is something that the Moscow Exchange would appreciate, as it would money from investors experienced in western markets.

Among recent news on the Russian front is the country’s slashing of its GDP growth forecast for 2013 to 2.4%--down from previous 3.6% -- based mainly on Russia's 1.1 % growth rate in the first quarter, down from 4.8% in 2012.

While economic growth is essential for a diversified business like the Moscow Exchange, the risks for investors also include uncertainty over policy reforms as well as weaker than expected volumes, linked to pricing pressure on trading and listing fees and increased competition from other exchanges.

The world’s economy is not in a good place in general and Russian economic uncertainty is just another reason US investors are wary.

“Economies and stock market are two different animals now,” says Alen Valdes, Director of Floor Operations for DME Securities in New York. In the US, he said, the economy is weak, with a 7.6% unemployment rate and millions of people on food stamps, but the stock market is strong. Same in Russia, he said, the market can get strong despite weakening economy.His company, however, refrains from investing in Russian stock market and deals primarily with companies that have underlying assets.

One of the challenges in making Russia more attractive -- as strange as it sounds in the 21st century – is the fear of communism and memories of the Iron Curtain. Mark Otto, director at Knight Capital Americas, an American global financial services firm that deals with emerging economies, primarily China, says that one of the concerns about investing in Russia – in addition to a commodities-based economy and high risk of inflation – is “the fear of government bringing in regulations and taxation.”

The Moscow Exchange attempts to create sound corporate governance that sets the tone for other institutions in Russia and eases international business. Speaking about changing the financial markets landscape in Russia, Shemetov said: “Our first goal is to be a good example of Russian financial infrastructure”

Lingering Iron Curtain memories may seem like an issue too silly to form a real roadblock (after all, the USSR collapsed more than two decades ago), but it turns out Americans are still fearful: “The Americans that are part of the baby boomers grew up as part of the cold war and the fear that was instilled – and the whole idea of the KGB versus our CIA – that has to go away,” said Ben Willis, senior floor broker for Albert Fried & Company at the New York Stock Exchange. He added, “I don’t think that Russia will have the same image of the younger generation that is entering the marketplace now.”

This generational change will happen over time but investors could continue thinking of Russia as a “communistic state” with managed democracy and a government-regulated economy unless the overall business climate improves. Investors are keeping an eye on the correlation between Russian politics and business and the perception is that the government, not the market, decides who runs the most lucrative businesses and profits on opportunities.

Brank thinks that no matter how much is done to remove barriers and open access, capital flight continues to be a problem. “The perception remains that Russia is a tough place to do business and this hurts the government's ability to attract capital.”

Katya Soldak is a New-York-based journalist and the editorial director of Forbes Media’s international editions. Her strongest focuses are Eastern Europe and anything

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Katya Soldak is a New-York-based journalist and the editorial director of Forbes Media’s international editions. Her strongest focuses are Eastern Europe and anything related to Post-Soviet territory. Katya is the director of the documentaryThe Long Breakupand the author of the memoir-essayThis Is How Propaganda Works, about growing up in the Soviet Union.